Overstock.com 2007 Annual Report Download - page 65

from $324.9 million in 2005 to $303.2 million in 2006, while fulfillment partner revenue experienced 2% growth, from $474.4 million in 2005 to
$484.9 million in 2006.
Our fourth quarter revenue declined 7%, the same percentage decline we experienced in Q3, and total revenue was down 1% for the year. We believe
that these decreases were primarily the result of our infrastructure upgrades in the last half of 2005, which resulted in an unsatisfactory shopping experience
for many of our customers and affected both repeat and new customer sales in 2006. We believe that a key to future revenue growth is to increase our Website
conversion rate—defined as the percentage of visitors to the website who make a purchase. The areas of our business that most directly affect conversion rate,
including personalization of the website, customer retention, e-mail marketing, and site design and layout, are the responsibility of our internal marketing
department. Within each of these areas, we have identified and made progress on initiatives that we believe can improve conversion, including outsourcing to
third-party providers certain aspects of the functionality on the website, such as the engine that provides product recommendations to customers visiting
product pages and the gift center that went live during the fourth quarter.
Gross Margin
Total Gross Margin—For the years ended December 31, 2005 and 2006, total cost of goods sold increased $10.9 million or 2%, from $682.4 million in
2005 to $693.4 in 2006, resulting in a decrease in gross profit of 19% (from $116.9 million in 2005 to $94.8 million in 2006) during the same periods. As a
percent of total revenue, cost of goods sold increased from 85% to 88% for those respective periods, resulting in decreased gross margin of 14.6% and 12.0%
for the years ended December 31, 2005 and 2006, respectively. Cost of goods sold also included stock-based compensation related to the adoption of
SFAS 123(R) in 2006 of $412,000 during the year ended December 31, 2006 compared to $6,000 of stock-based compensation in 2005.
Generally, our overall gross margins fluctuate based on several factors, including our product mix of sales; sales volumes mix by our direct business and
fulfillment partners; changes in vendor pricing; lowering prices for customers, including competitive pricing and inventory management decisions within the
direct business; warehouse management costs; customer service costs; and our discounted shipping offers. Discounted shipping offers reduce shipping
revenue, and therefore reduce our gross margins on retail sales.
Direct Gross Margin—For the years ended December 31, 2005 and 2006, gross profit for our direct business decreased 57% from $42.5 million in 2005
to $18.3 million in 2006. Gross margin for our direct business decreased from 13.1% to 6.0% for those respective periods. The lower gross margin
experienced by the direct business were primarily the result of lowering prices to our customers in an effort to significantly reduce inventory levels, which
decreased from $93.3 million at the end of 2005 to $20.3 million at the end of 2006.
Fulfillment Partner Gross Margin—For the years ended December 31, 2005 and 2006, our fulfillment partner business generated gross profit of
$74.4 million and $76.5 million, respectively, an increase of 3%, also resulting in increased gross margin of 15.7% and 15.8% for those respective periods.
Fulfillment costs
Fulfillment costs include all warehousing costs, including fixed overhead and variable handling costs (excluding packaging costs), as well as credit card
fees and customer service costs, all of which we include as costs in calculating gross margins. We believe that some companies in our industry, including
some of our competitors, account for fulfillment costs within operating expenses, and therefore exclude fulfillment costs from gross margins. As a result, our
gross margins may not be directly comparable to others in our industry.
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